Page 737 - The Principle of Economics

CHAPTER 32 THE INFLUENCE OF MONETARY AND FISCAL POLICY ON AGGREGATE DEMAND 757
Fed to be sheltered from short-run po- litical pressures.
The Fed is an independent agency that reports to Congress but doesn’t take orders from anyone. Monetary pol- icy and short-term interest rates are determined by the Federal Open Market Committee (the FOMC), which consists of the 7 governors of the Fed plus the 12 presidents of the regional Federal Re- serve Banks. The regional presidents vote on an alternating basis but all partic- ipate in the deliberations.
A key to the independence of the Fed’s actions lies in the manner that ap- pointments are made within the system. Although the 7 Federal Reserve gover- nors are appointed by the president and confirmed by the Senate, each of the 12 Federal Reserve presidents is selected by the local board of a regional Federal Reserve Bank rather than being respon- sive to Washington. These regional pres- idents often serve for many years. Frequently they are long-term employees of the Federal Reserve system who have risen through the ranks. And many are
professional economists with expertise in monetary economics. But whatever their backgrounds, they are not political ap- pointees or friends of elected politicians. Their allegiance is to the goal of sound monetary policy, including both macro- economic performance and supervision of the banking system.
The latest challenge to Fed indepen- dence would be to deny these Federal Reserve presidents the power to vote on monetary policy. This bad idea, explicitly proposed by Senator Paul Sarbanes, a powerful Democrat on the Senate Bank- ing Committee, would mean shifting all of the authority to the 7 governors. Be- cause at least one governor’s term ends every two years, a president who spends eight years in the White House would be able to appoint a majority of the Board of Governors and could thus control monetary policy. An alternative bad idea, proposed by Representative Henry Gonzalez, a key Democrat on the House Banking Committee, would take away the independence of the Fed by hav- ing the regional Fed presidents ap-
pointed by the president subject to Sen- ate confirmation.
Either approach would inevitably mean more politicalization of Federal Reserve policy. In an economy that is starting to overheat, the temptation would be to resist raising interest rates and to risk an acceleration of inflation. In the long run, that would mean volatile in- terest rates and less stability in the over- all economy.
Ironically, such a move toward cut- ting the independence of the Federal Reserve is just counter to developments in other countries. Experience around the world has confirmed that the indepen- dence of central banks such as our Fed is the key to sound monetary policy. It would be a serious mistake for the United States to move in the opposite direction.
SOURCE: The Boston Globe, November 12, 1996, p. D4.
shifts to the right. Conversely, a decrease in the money supply raises the equilibrium interest rate for any given price level and shifts the aggregate-demand curve to the left.
N Policymakers can also influence aggregate demand with fiscal policy. An increase in government purchases or
a cut in taxes shifts the aggregate-demand curve to
the right. A decrease in government purchases or an increase in taxes shifts the aggregate-demand curve
to the left.
N When the government alters spending or taxes, the resulting shift in aggregate demand can be larger or smaller than the fiscal change. The multiplier effect tends to amplify the effects of fiscal policy on aggregate
demand. The crowding-out effect tends to dampen the effects of fiscal policy on aggregate demand.
N Because monetary and fiscal policy can influence aggregate demand, the government sometimes uses these policy instruments in an attempt to stabilize the economy. Economists disagree about how active the government should be in this effort. According to advocates of active stabilization policy, changes in attitudes by households and firms shift aggregate demand; if the government does not respond, the result is undesirable and unnecessary fluctuations in output and employment. According to critics of active stabilization policy, monetary and fiscal policy work with such long lags that attempts at stabilizing the economy often end up being destabilizing.